Every now and then the discussion about costs in the banking system surfaces. The latest example was in the Ziarul Financiar of last wednesday in which professor Dan Armeanu, under the title “Why I Agree With Mister Governor,” gives his opinion. I’ll not go into the content of the article but it didn’t seem very scientific to me. You can find it here.
The discussion about cost in the banking system is an old one. I myself took the initiative years ago to commission a study by a third party, Roland Berger, about costs in the Romanian banking system. It was financed by 3 banks. High costs are not in the interest of the bank and more expensive financial services are not in the interest of their clients. I thought a study might help to get a discussion going. The document was quickly marginalized and it is now gathering dust somewhere on shelves in institutions. It is good to see that nowadays there is more interest in the cost of the Romanian banking system.
What The Governor Said
According to the press, the Governor said that, possible due to insufficient competition, banks can pass on costs to their clients that are the result of deficiencies in their internal organization or risk assessment. He called for stronger competition in the financial system. Articles in the press can be found here (Gandul) and here (Mediafax).
I found it interesting that he mentioned the cost of internal organization and risk management. These are in my view the cost that are less likely to be passed on but I agree that stronger competition would make this even less likely.
Two Types Of Costs
We can split cost that banks are facing roughly into two groups. So far I haven’t seen this being pointed out. Maybe an interesting subject for a study by the professor ?
Exogenous, System Related
The first group are those that are linked to the environment and are the same for all banks in the country. We can call them exogenous factors. Banks will manage these as good as they can but these costs will be passed on to the clients, much in the same way as a VAT increase is paid for by the consumer. Maybe not from one day to the other, but over time this is the case.
Examples of this type of costs are related to:
- Deposit insurance contributions,
- Minimum reserve requirements
- Measures imposed by Consumer Protection Authorities
- Increased liquidity requirement
- Additional capital requirements
- Repossessing of assets
- Collection costs
- Infrastructure related costs
- Regulatory costs
- Accounting rules, like non accrual policy, write off policy
- Taxes, including VAT
- Certain legal costs, like checking of ownership titles
- Country risk costs
Please note that I am not necessarily against the above mentioned costs, I merely point out that these costs are system related and they cannot be influenced by individual banks and are as such not going to be influenced by fiercer competition (on national level). On the other hand they might reduce competition and competitiveness. Almost all of the above mentioned cost have gone up over the last years.
Then we have the costs that are not linked to the environment but are the results of decisions made by individual banks. These are the costs that were mentioned by Governor Isarescu. If a bank decides to assume more risk in its lending activity than others and as a result has more credit losses, then this bank will not be able to pass this cost on to its customers for the simple reason that the clients will not be willing to pay more for credits and will choose another bank. The same applies if a bank decides to open branches without having the business volumes to justify them. The related costs will be translated into lower profits or losses for the shareholder. Banks with a higher cost structure cannot be more expensive than more efficient banks. Indeed, the fiercer the competition the lower the possibility for banks to pass this type of costs on to the client. Exactly the fact that some banks are still reasonably profitable and others severely loss making shows that this cannot be passed on. Banks make losses because of credit losses and investments in their branch networks. These are not the exogenous factors.
So, what to do?
If we want to have cheaper financial services in Romania and cheaper credit, we should be willing to address – at least question and challenge – the exogenous costs as well. This can only be done on the level of the system. Individual banks cannot influence them. These are rules and laws that are the result of a democratic processes and banks need to respect the outcome. At the same time there is very little real dialog and consultation taking place during this process. The opinion seems to be that banks are making enough profit and that the costs of the measures don’t matter. I have heard this more than once from the side of lawmakers. I wanted to point out that this is naive. Measures that increase the costs for banks on a systemic level will increase the cost of lending and financial services and this will negatively affect economic growth. Again, if politicians accept this, that is not my business but up to the electorate. I would like to see a proper impact analysis and debate for the benefit of the country. And as far as competition is concerned? I’ll write about this soon.